NEW YORK, May 16 (NIKKEI) - The U.S. may be only a few weeks away from defaulting on its debt over political gridlock, thrusting the global financial system into unknown territory that threatens to pummel stock prices and ignite a run on banks.
But views are mixed as to whether this would be a major blow for the dollar — which has served as the world’s major reserve currency since World War II — or counterintuitively further enhance its safe-haven status as money flocks toward stable investments.
“On a very essential level, this is a threat to global stability and U.S. dollar dominance,” said Juan Perez, director of trading for Monex USA, in an interview.
Although for now the market does not seem to expect the U.S. to default, Perez said it could be a possible “Brexit moment” for the world’s biggest economy.
“How much political friction do you have in your country that you’re preventing yourself from borrowing from yourself?” he asked.
A default on U.S. debt would likely be welcomed by China and Russia, which have been pushing for a “de-dollarization” to free themselves from a global financial system reliant on the greenback and decision-making in Washington.
On Monday, Treasury Secretary Janet Yellen again warned that the U.S. could run out of money to pay its debts by June 1 if Congress does not vote to raise the debt ceiling — the self-imposed limit on how much money the federal government can borrow.
The standoff over the debt ceiling comes from a divided Congress where the Republican-majority House, led by Speaker Kevin McCarthy, is demanding that President Joe Biden agree to massive spending cuts in order to avoid a default.
Biden has called upon Congress to raise the debt ceiling in order to avert fiscal chaos.
Biden and McCarthy met Tuesday for further negotiations, where the speaker confirmed that a deal was possible but that the two sides remain far apart.
“We’ve got a lot of work to do in a short amount of time,” McCarthy said after the meeting.
Biden will also be cutting his Asia trip short in order to return and focus on reaching an agreement before the end of the month.
In 2011, when the U.S. came close to defaulting on its debt in a similar showdown between a Republican-led House and the Obama administration, America’s credit rating declined for the first time and stocks plummeted by roughly 15% in the third quarter.
But the dollar gained in value — a counterintuitive response to overall financial risk that could happen again.
“The commonsense approach would be bad news for the U.S. is bad news for the U.S. dollar, but that’s not the case,” said Amarjit Sahota, executive director of Klarity FX, in an interview. “You start getting a shift out of risk assets and the dollar benefits there.”
Other safe-haven assets, such as the yen, would also be in a position to benefit as they have in previous periods of instability.
“I’m not sure whether the yen will get a significant appreciation in this particular cycle, but it’s certainly geared up for that,” Sahota said.
Just how much may depend on how much the Bank of Japan is seen as willing to raise interest rates.
“If there’s any indication of that happening in the next six to eight months, that’s going to be another factor that could crush the buck and significantly increase the value of the yen,” Perez said.
